Trusts exempt from the 21-year deemed disposition rule (often associated with Canadian tax law) typically include Alter Ego Trusts, Joint Partner Trusts, and Spousal Trusts. These trusts defer capital gains until the death of the settlor or spouse, rather than triggering a deemed disposition every 21 years.
Trusts that are excepted from the 21-year anniversary rule are spousal/common-law trusts and alter-ego/joint spousal trusts which will only realize the deemed disposition of assets on the death of the spousal beneficiary or settlor of the trust, and then every 21 years thereafter.
The primary trust that avoids probate is a Revocable Living Trust, also called an Irrevocable Trust. This trust holds assets separate from the individual, allowing a successor trustee to manage and distribute them to beneficiaries after death without court involvement, bypassing the lengthy, public, and costly probate process. Both revocable and irrevocable trusts can avoid probate, but revocable trusts offer control during life, while irrevocable trusts offer more asset protection.
The crackdown has resulted in the ATO undertaking extensive audits of family trusts and historical distributions, and the issue of hefty Family Trust Distributions Tax (FTD Tax) assessments for noncompliance – being a 47% tax (plus Medicare levy) along with General Interest Charges (GIC) on any historical liabilities.
Bare trusts
Transfers into a bare trust may also be exempt from Inheritance Tax, as long as the person making the transfer survives for 7 years after making the transfer.
While few trusts are entirely tax-exempt, certain types, like Charitable Remainder Trusts, GST-Exempt Trusts, and specific Special Needs Trusts, receive significant tax advantages or exemptions, often by passing income to tax-exempt entities or individuals, or by meeting specific IRS criteria for estate tax avoidance (like Bypass Trusts) or generation-skipping tax (GST) relief. Most trusts still pay some tax, but benefit from deductions or exemptions (e.g., $100 or $300 for basic trusts).
The "5 by 5 rule" (or "5 and 5 power") in trusts allows a beneficiary to withdraw the greater of $5,000 or 5% of the trust's annual fair market value, whichever is higher, without triggering significant tax consequences, offering flexibility while preserving the trust's long-term integrity for the grantor's original purpose. If unused, the right lapses, but repeated lapses can have tax implications, so it's a strategic clause for asset management and tax planning.
While few trusts are entirely tax-exempt, certain types, like Charitable Remainder Trusts, GST-Exempt Trusts, and specific Special Needs Trusts, receive significant tax advantages or exemptions, often by passing income to tax-exempt entities or individuals, or by meeting specific IRS criteria for estate tax avoidance (like Bypass Trusts) or generation-skipping tax (GST) relief. Most trusts still pay some tax, but benefit from deductions or exemptions (e.g., $100 or $300 for basic trusts).
Disadvantages of putting your house in a trust include upfront legal costs and complexity, potential difficulty refinancing mortgages, the risk of losing control (especially with irrevocable trusts), the need for meticulous paperwork and ongoing management, and the fact that some tax benefits aren't guaranteed, with potential issues like losing capital gains tax relief or triggering other taxes. It also doesn't protect other assets from probate unless they are also in the trust.
For most people, a Revocable Living Trust is the best choice for putting a house in a trust, as it lets you keep control, avoid probate for the home, maintain privacy, and easily manage the property, while an Irrevocable Trust offers asset protection but sacrifices control and flexibility, making it better for specific goals like Medicaid planning.
Assets exempt from probate typically include those with named beneficiaries (life insurance, retirement accounts), jointly owned property with rights of survivorship, assets held in a living trust, and sometimes specific items like homestead property or a certain value of vehicles/household goods, depending on state law, allowing direct transfer to heirs without court involvement.
Some financial products and arrangements with 'Trust' in their description, such as the Child Trust Fund, investment trusts or Venture Capital Trusts, are not really trusts, so do not need to be registered.
You can avoid or reduce capital gains tax with trusts, primarily through Charitable Remainder Trusts (CRTs) (selling appreciated assets tax-free for income/charity), the stepped-up basis at death (for inherited assets from a revocable trust/estate), or using specific irrevocable trusts designed to hold assets to minimize tax on sales within the trust. The key is careful planning, often involving irrevocable structures or charitable giving, as standard revocable trusts don't avoid the tax until death for beneficiaries.
Suze Orman, the popular financial guru, goes so far as to say that “everyone” needs a revocable living trust. But what everyone really needs is some good advice. Living trusts can be useful in limited circumstances, but most of us should sit down with an independent planner to decide whether a living trust is suitable.
The main "new rule" for irrevocable trusts is IRS Revenue Ruling 2023-2, which eliminated the tax benefit of a "step-up in basis" for assets in many irrevocable grantor trusts, meaning beneficiaries inherit the original cost basis, not the fair market value, potentially triggering significant capital gains tax when sold. This change impacts trusts designed to keep assets out of the grantor's taxable estate, forcing planners to choose between estate tax reduction and avoiding capital gains for heirs, especially as the large estate tax exemption may revert in 2026.
Irrevocable trust
Most trusts can be irrevocable. An irrevocable trust offers your assets the most protection from creditors and lawsuits.